What is “Rich”?

An opinion piece in Friday’s Washington Post purported to tackle five “myths” about the millionaires. In general I’ve enjoyed these ‘five myth’ pieces. But this one seemed to reflect a major problem with how we talk about wealth in this country.

The first “myth” tackled in the piece was “Millionaires are rich.” The author, John Steele Gordon, provides two points of reference/evidence for the idea that millionaires aren’t rich:

In order to make the Forbes list of the 400 richest Americans, one must top $1 billion. (In 1982 the necessary figure was $75 million.)

“Today, $1 million in the bank generates only about $50,000 per year in interest. That isn’t chump change, but it’s roughly equal to the 2010 median household income.”

The first point isn’t really material, unless you only regard the top 0.000128% of Americans as “rich.”

It’s the second point that stands out to me. This is the only real measure the author provides for evaluating the relative wealth of millionaires. But let’s follow the logical sequence he lays out here: First, the annual interest on $1 million is approximately $50,000. Second, the 2010 median household income was approximately $50,000. By implication (“This isn’t chump change, but…”), both the millionaire and the median income earner have about the same amount to live on each year.

Have you already spotted the glaring problem? In order to bring in the yearly $50,000, a median income earner must work for her income. A millionaire, on the other hand, must do nothing more than collect the interest paid. If a median income earner should lose his job, he receives no more income. If a millionaire loses her job, she will still receive the $50,000 each year. In a time of huge unemployment, how can the author not see this distinction?

Furthermore, a millionaire has lots of options with that $1 million sitting in the bank. First, he could choose to live a comfortable middle income life off the interest, leaving the principle in the bank to keep generating a return for the future. Second, she could get a job and expand her income beyond this base safety net. Third, he can invest some of that $1 million in ways that will increase future earnings. For example, a millionaire could spend some of her principle to pay for more education. She could then use the increased wages from a subsequent job to rebuild the principle and ensure a bright future.

That’s more difficult for a median wage earner. First, he must first find time to add education while also working the job that brings in the $50,000; he doesn’t have the luxury of living off of self-realized interest while pursuing greater opportunity. Second, without a pool of personal wealth to tap, she must find someone else willing to pay for her education, either through grants or loans. If loans, she is now facing the negative side of interest.

The real world logic of the author’s point boils down to this: By simply keeping his money in a bank, a millionaire can receive enough interest each year to pay the annual income of an American who makes more than 50% of all Americans (the definition of ‘median’). That sounds like a pretty good definition of “rich” to me.

5% would indeed be a good return. savings accounts rates are more like 1% right now, though. So it’s more like $10,000. A five year cd right now gets you about 2%, so $20,000.

Plus, most people who have a net worth of $1MM, will not have $1MM sitting in cash. Almost universally, they will have their home as their primary asset and I bet that most often, those homes will be like the 900 sq ft, 2 bedroom, quasi mobile trailer home that I live in, which is on the market at $800k. Down the street is a typical new england clapboard, about 1700 ft, and it is on the market at $2.3MM.

Even if they have $1mm in liquid assets, if they are smart the majority of those assets would be in tax-free IRAs and Roth IRAs, which are frozen until retirement.

So yeah, if someone has $1MM in cash in the bank, I agree that he is rich. But for a larger group of people with $250k-$750k incomes and relatively high taxes, expenses, etc., this still may not be the case. Not poor, by any means.

What is interesting, is that the rise in the level of income inequality really took off in about 1984.

I can’t find the link, but this time-period roughly coincides with a shift on wall street. Previously, owners had been paid through dividends, which are taxed at regular income levels (at least until 2003). After the shift, more and more owners wanted a vehicle to shift income from dividend income to capital gains income, which is taxed at a lower rate.